Orr testifies in favor of deal to end swap agreements

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A $285 million financing proposal for Detroit before U.S. Bankruptcy Judge Steven Rhodes has evolved over months of cost-benefit analysis, hardball tactics, lawsuit threats and even calling upon the U.S. Securities and Exchange Commission, Emergency Manager Kevyn Orr testified Friday.

Orr testified in an ongoing hearing on a plan to end burdensome swap agreements with banks and get $120 million in "quality of life" loans for city operations that he had the city's attorneys craft possible lawsuits against Zurich-based UBS AG and Merrill Lynch, a unit of Bank of America that took over the creditor position of SBS Financial Products Co. in that deal.

Orr had even consulted the SEC about possible action against the creditors in the weeks before filing for bankruptcy on July 18, he testified in an ongoing motion hearing about Detroit's Chapter 9 bankruptcy.

"Initially, the (swap) counterparties took a fairly strong position that they had a secured interest. Certainly that's what I experienced on the business side. And (they felt) that this whole (lending) position had been vetted and approved," he told the court.

"We wanted to make sure they understood ... we believed there was an opportunity to litigate that issue, and perhaps undermine that security interest."

In the run-up to reaching a "forbearance agreement" with the swap counterparties a few days before Chapter 9, Detroit officials had explored the possibility of challenging the original 2005-06 lending agreements on several grounds, including that the city was not authorized to enter into them and that they were "fraudulently constructed," Orr said.

Also, the new financing deal to terminate the swaps for $165 million was the banks' best offer, Orr said in court, after the city had tried to offer $145 million-$150 million. Detroit originally rejected its offer, before coming to a deal in the evening hours last week.

The financing from Barclays Capital Inc., if approved, would terminate both counterparties' swaps position and lend another $120 million or more in "quality of life" loans to fund operations like blight removal, public safety and technology infrastructure. Orr said in court Friday that he believes the financing is available until Jan. 31.

Creating possible ammunition for the fraud claim earlier last year was a recent series of U.S., British and Swiss charges alleging UBS conspired with dozens of traders and managers to skew interest rates to make money on trades, particularly involving the London Interbank Offered Rate. UBS agreed in December 2012 to a $1.5 billion payout to settle its criminal charges.

But the legal arguments in Detroit's favor, Orr said, were largely counterbalanced by the factual arguments favoring the banks, including that the city had reviewed and approved the swap deals on advice from its attorneys. So its chances in litigation were uncertain, he said.

If unsuccessful, the city could have faced an immediate obligation to pay "hundreds of millions" to the counterparties and possible litigation costs including the opposition's attorney fees.

"The city is down from (a peak of) 22,000 FTEs (full-time equivalent positions) to about 9,600 today," he said. "You can't cut any more to make up $200 million in losses."

Megan Stinson, a spokeswoman for Zurich-based UBS, said the bank couldn’t immediately respond to Orr’s testimony.

Detroit attorneys told Rhodes on Dec. 20 that that law firm Pepper Hamilton LLP has issued "litigation hold notices" for the city to UBS and Bank of America Merrill Lynch in the massive 2005 and 2006 credit default swap deals, if it could not reach the new deal hashed out in negotiations Dec. 23.

Under an agreement recommended for approval earlier this week by Chief U.S. District Judge Gerald Rosen in Detroit, a lead mediator in the bankruptcy, the banks will now agree to allow the city to terminate its contracts for $165 million, a 43 percent discount from the $293.3 million the banks could stand to collect.

Originally, the city and the banks had agreed to nearly $230 million in a $350 million financing deal to terminate the interest-rate swaps that have cost the city about $202 million since 2009. That was a 25 percent discount, a figure Rhodes has said previously in court is akin to a court judgment in favor of an adverse creditor.

Creditors led by bond insurer Syncora Guarantee Inc. oppose the settlement, saying it’s too costly. The city didn’t prove it would lose if it sued to cancel the contracts instead of settling, Syncora said.

Syncora said in court papers that the deal could cost it money as the insurer of some of the bonds and swaps. Under the settlement, Syncora would be released from any obligations related to the swaps, according to the city.

Friday's session ended after Corinne Ball of Jones Day, an attorney for Detroit, made a closing argument in favor of the proposed settlement, saying it was best the city could do. Should Rhodes reject the deal, the city will be forced to litigate the swaps contracts. A settlement saves time and money, she said.

“We need to get on with it,” Ball said.

Court will resume Monday, when critics of the deal make their case for rejecting the proposal.

During the hearing, security officials removed a heckler from the courtroom. The protester yelled, "Jones Day is not the city of Detroit, nor is the emergency manager."

Orr left his role as a partner in the Cleveland-based Jones Day international law firm after the state hired him as emergency manager. Detroit hired Jones Day to lead a financial restructuring before July's bankruptcy filing.

Rhodes told Orr afterward he could leave the courtroom immediately "if there are any further outbursts like this."